Budgeting & Net Worth

Creating a budget is the first step to controlling your spending and helping you to build wealth.

Why you should create a budget

• Track and optimize your spending
• Help free up funds to pay down debt
• Find ways to save and invest
• Identify areas of overspending that you might be unaware of
• Gain more control of your finances
• Prepare for large and small expenses (no more surprises)
• Reap the benefits of increased overall financial planning for short- and long-term needs

How to create a budget

• If you are comfortable using an app to share your account information, there are many apps that will create a budget for you, including Mint, YNAB (You Need A Budget), and Personal Capital. See Savings Apps page for a list of other solutions.
• If you prefer to track your spending on your own, you can print out an online template or, of course, use just plain paper and pencil.
• Start by tracking a recent full month of actual net income and expenses:
  • Your net income and expenses would go into a column labeled “Actual.”
  • You can track expenses by category, such as housing, food, and transportation. You can, of course, add other categories or line items as needed.
  • In addition to tracking monthly expenses, make sure to also include expenses that are paid quarterly or yearly (such as some insurance premiums, estimated tax payments, and memberships). Just figure out the yearly expense and divide that total by 12 to come up with the monthly amount for these items.
  • Calculate the bottom line: Net Income minus Expenses.
    • If this number is negative, then you are spending more than you are earning, and you should lower your spending or try to increase your earnings (or both).
    • If this number is 0 AND you are actively saving and contributing to a 401(k) or similar plan (if you have access to one) and/or to an IRA and you have no non-mortgage debt, that’s a different case.
      • Try to adjust your spending downward with the goal of contributing 10-20% (or more) of your gross income towards retirement, including any company matching funds. (See “What percent of gross income to save for retirement?“)
    • If this number is 0 AND you have nothing going into saving each month or you are not contributing to any available 401(k) or similar plan or you have outstanding non-mortgage debt, you should consider lowering your spending or finding ways to earn more (or both) if you want to start building your retirement savings.
    • If this number is greater than 0, that means you can consider saving or investing more or applying more towards paying off any debt.
• Create a realistic budget for how you would like to allocate your income to expenses going forward:
  • Fixed expenses like rent, mortgage, insurance, etc. are harder to change than variable expenses (restaurant, entertainment, etc.), but still can be lowered by refinancing, moving, changing service providers or plans, renegotiating rates, etc.
• Compare your actual spending to your budgeted amounts:
  • Calculate Actual Monthly Expenses minus Budgeted Monthly Expenses.
  • Continue tracking each month going forward to monitor your progress and have a monthly snapshot of your finances.
  • How are you doing? Are there areas or categories where you can make changes in your actual spending—even small changes–to improve your overall financial picture?

The 50/30/20 Rule

• Some people use the 50/30/20 Rule in budgeting: 50% of after-tax income for necessities (food, housing, insurance, transportation, basic clothing, etc.); 30% of after-tax income for discretionary spending (restaurants, vacations, other clothing, gym memberships, entertainment, etc.); and 20% of after-tax income for savings, debt repayment, and investments.
• The 50/30/20 Rule is just a guideline, not a hard-and-fast rule.
• One of the benefits of analyzing your budget using a 50/30/20 allocation is to be able to measure your spending against a benchmark so that you can identify areas that you may want to focus on.
• A true 50/30/20 split may be hard to achieve, especially if you are just starting out, live in a city with very high housing costs, have a large student-loan balance, or support a family on one income.

What is net worth?

• Net Worth = Total Assets – Total Liabilities
• Net worth shows you a snapshot of your financial picture at a particular point in time.
• Tracking your net worth periodically is a good way to monitor your overall financial situation.

How to calculate net worth

• Net Worth = Total Assets – Total Liabilities
• As mentioned above, if you are comfortable using an app to share your account information, there are many apps that will calculate your net worth for you. See Savings Apps page for a list of solutions.
• If you prefer to track your net worth on your own, you can use Otterwize’s free Excel template as a guide by contacting us or of course use just plain paper and pencil.
• If you use Ottterwize’s free Net Worth Template:
  • For Total Assets, add up the current value of:
    • any accounts you have (checking; savings; money market savings accounts; CDs; investment accounts; retirement accounts such as 401(k), IRAs, etc.)
    • any unbanked cash you may have
    • any real property you own (but see note below about primary residence)
    • any big-ticket tangible personal property that you could sell if you needed to, such as a car, jewelry, artwork, etc.
    • If you have a fully-vested pension or a life insurance policy with a cash value component, you can include the current cash value of these in Total Assets.
  • For Total Liabilities, add up the current amount of:
    • outstanding debt (mortgage; credit-card debt; student debt; car loans; home equity loans; consumer or personal loans, other loans)
    • other monetary obligations including any delinquent taxes (back taxes) due
  • Do not include in Total Assets any contingent right to receive future alimony payments, and in Total Liabilities do not include any contingent obligation to pay future alimony, child support, or similar obligations.
  • This net worth calculation excludes any intangible property you may own—copyrights, trademarks, patents, goodwill, and other intellectual property—because many lenders want to see just your tangible net worth. It can also be difficult to assign a fair value to certain intangible assets.
  • Whether to include primary residence when calculating net worth:
    • Some people exclude their primary residence from their net worth calculation, arguing that it is an illiquid investment and that even if they were to sell the property, they would still need to incur the expense of living somewhere else. Other people include their primary residence in their net worth calculation, arguing that it is an asset just like any other asset (whether liquid or illiquid). Some people take the middle ground and calculate their net worth both ways (net worth with primary residence and net worth without primary residence).
    • We think that it makes sense to include the equity in your primary residence (current value less mortgage balance remaining) when calculating net worth. Your home is a valuable asset that usually appreciates over time. Suppose you bought your house 10 years ago for $150,000 with $50,000 down and a $100,000 mortgage. The equity in your home at that point was $50,000. And suppose the house is now worth $300,000, and your mortgage outstanding balance is $80,000 (due to payments of mostly interest in the earlier years on a balloon mortgage). The equity in your home today would be $300,000 – $80,000 = $220,000. We think it makes sense to count that $220,000 in calculating your net worth. (An asset of $300,000 and a liability of $80,000).
    • You can, of course, calculate your net worth any way you want. Just make sure that you are aware of which method you choose and that you are consistent when you compare the change in your net worth over time.
    • In deciding whether you want to include or exclude your primary residence in your net worth calculation, you should also consider the purpose of the net worth calculation. For example, if you are periodically analyzing your net worth as a barometer of your financial progress, we think it makes sense to include your primary residence. If you are calculating net worth for the purpose of measuring the amount you can safely withdraw each year in retirement, then you probably should exclude your primary residence from the net worth figure (or at least a portion of the value, if you think you may sell and/or downsize your housing).